Can an industrial strategy help drive productivity growth?

GILES WILKES AND ANDY WESTWOOD

The Labour government is not yet three months old, but is committed to solving problems decades in the making. The greatest of these is the UK’s flagging growth rate, a reflection of disappointing levels of productivity going back to the Financial Crisis or even earlier.

It was around the time of that crisis that daring thinkers started to ask if that trauma and sagging productivity might be blamed on the lack of a “proper industrial strategy”. Remember Lord Mandelson calling for more real engineering, less financial engineering – and for ‘new industries and new jobs?’ The heretical thought was that maybe the free market, left to its own devices, did not smoothly allocate resources to where they were most efficiently deployed.  Sometimes private sector interests gambled recklessly, chased asset bubbles, neglected long-term investments in favour of a quick buck, and fell back on the government when the crash came. Perhaps the guiding hand of the government was needed to make a fair, productive economy work well?

There isn’t the space to detail all the starts and stops that industrial strategy underwent in the years since. But perhaps a page can be turned, with Labour campaigning on the promise of an industrial strategy to transform the UK into a more productive, green and secure economy. There is even an ugly-sounding word for it – “securonomics” – and a cluster of new institutions sketched out for its delivery including Great British Energy, a National Wealth Fund and the revival of the previously abolished Industrial Strategy Council. Following Labour’s Party Conference we also now have a timeline – with Rachel Reeves promising an initial outline alongside the Budget and the full version in Spring next year.

We use the word “perhaps” advisedly. Industrial Strategy is much written about, but the link between it and productivity growth needs more exploration.  This is why The Productivity Institute and Institute for Government recently held an event titled “How can the new government’s industrial strategy help boost productivity”. One unhelpful answer is to suggest that industrial strategy is simply about productivity by definition. Anything that might improve the use of resources in the country might be included. Improved school standards? Better roads? Smoother trade links with Europe? A smarter bankruptcy regime? All part of our industrial strategy!

We reject this, and not just for niggling semantic reasons. Whatever your definition of it, the concept of industrial strategy has to involve focus, selecting carefully the targets and objectives. It should be a conscious allocation of resources towards certain goals using tightly determined criteria. As one speaker at the TPI-IFG event observed, having too wide a remit gives the hard-working analysts helping the Industrial Strategy Council an impossible task in monitoring how the strategy is faring.

There needs to be a little humility in how industrial strategy is designed. It cannot be based upon blind faith that wherever the government chooses to intervene, it will do so in a smart and beneficial way. This is not a dig at governments, but rather an expression of our honest appreciation for just how brilliant are the normal operations of a decently-functioning free market. In spite of that crisis in 2008-9, the capitalist machine is still a miracle. It hums with a limitless array of price signals, competitive forces, shifting trends, consumer demands, hard-to-discern cost curves and technological trends. It isn’t perfect, but to intervene in it and expect better outcomes requires a hard-edged rationale. Sometimes this is easy to find – there are public goods that only a government can provide in the right way – but the more selective, goal-oriented interference inherent in industrial strategy requires a high bar.

Industrial Strategy must make – and stick to – choices.

Therefore a strategy cannot and should not seek to do “everything”, but must mean choices, focus, a decision to place your bets. The decision to have one must be founded on a strong sense of where investment might yield disproportionate results. In these times of rapid technological change and new evolving global pressures there will be a constant flow of firms and sectors desiring more subsidy. A good strategy and a strong government will need to remain firm about what is not included. Seen more positively – across the UK economy, most things are going fine, and someone from the Government cannot really help.

Three starting points for focus: net zero, sectors with potential, and regional laggards

But where should the government focus, and how? Here we think Labour has provided some useful early clues. Foremost is the focus on net zero and the energy transition. Outside of a major war, history contains no example of an agenda that so obviously requires strategic government involvement as decarbonisation of our energy system, transport, agriculture, housing and industry.  By some estimates, the amount of annual investment needed globally runs into the trillions.  The UK’s place within this transition is multi-dimensional: as an energy user, a provider of technology, a financial centre, and more. Not everything will fit naturally with the UK’s strengths – there will be multiple make-or-trade decisions.  But even if low carbon technologies prove ultimately the most efficient, the gulf between the economics of energy today and in the future is sufficiently vast that state support over it will be longstanding.

Net zero is the easy choice.  What are the others? Guided by our concern with productivity, we think other choices need to be based on solid analysis as to where the UK productivity is lagging its potential. In places this can lead to sectoral policy – “classic” industrial strategy of the old school sort, with extra attention paid to sectors like aerospace, automotives, creative and digital. These are all industries where the UK has some deep-set strengths, and the potential to do better in the global marketplace.  The Department for Business and Trade has the analytical resources to evaluate where decent growth, UK comparative advantage and sensitivity to government policy might all come together.

Another lens to look through is the geographic one, and our underperforming regional, and second tier cities. Britain will not recover its overall productivity if it leaves swathes of the country far behind their potential. There are plenty of policy questions here, many of which go beyond the traditional definition of industrial strategy. Devolved powers over public spending priorities and greater investment in transport networks are a key part of the policy set. But some are very much related to industrial strategy, such as the support for specific clusters and activities. Emulating the US approach in the Midwest, where they are addressing similar challenges related to deindustrialisation, the Mayoral Combined Authorities (MCAs) must themselves focus on key initiatives and sectors suited to their strengths. To do this well, a first priority is to ramp up the capacity of MCAs to run programmes and deliver key projects. They also need to be in the lead in creating institutions able to diffuse new technologies in these city regions. This should include the skill system, which is key to improving the absorptive capacity in local firms – their upper technical and management skills.

Delivering is hard

There isn’t sufficient space to set out all the delivery challenges of industrial strategy, which cannot in any case be discussed in abstract. They depends on the nature of the industry or challenge in question. Supporting a new fleet of small modular nuclear reactors has little in common with the task of boosting UK creative industries, for example.

The Productivity Institute will return in due course to the topic of industrial strategy tools. At this stage we restrict ourselves to the following observations

• At a high level, the classic problems of Whitehall delivery apply: sticking to a long term plan, coordinating multiple layers and silos of government, having reliable mechanisms for business engagement in its inception.

• The proposed mission architecture may prove helpful, if the government sticks to it. It would make a nice change if there was one overall plan for the next five or ten years, rather than the dozen or so that the last governments have produced. But that is just a necessary condition, and not a sufficient one.

• Compared to normal private sector investment, what government projects lack is the equivalent of a market mechanism to weed out bad ideas and boost the good. In the private sector, competitors and investors stop activities that are going nowhere. Lacking this, the government can compensate with a very risk-averse approach, consulting endlessly before embarking on an investment and wrapping it up in reporting requirements.  We think the Industrial Strategy Council can play a really useful role here – setting out success metrics in advance, and monitoring progress against these milestones.
• The support of the Treasury and the Chancellor, Rachel Reeves, is crucial. A Treasury merely inclined to tolerate an industrial strategy might easily lead to projects being curtailed too soon.  One that is more enthusiastic can not only help ensure steady funding, but bang heads together across Whitehall.

To return to the question that heads up this blog: can the industrial strategy boost UK productivity? Our tentative holding response is that it can, but only if the government is rigorous, united, focused in delivery and ruthless about what isn’t working – to a degree that has not been seen for a long time. It needs a thick skin against the complaints of the sectors being left out; an unsentimental willingness to cut back the clearly failing ideas, alongside superhuman patience for the ones that need long-term commitment; a No.10 willing to bash heads together to enforce Whitehall cooperation; and positive, imaginative analysis of where the best opportunities lie.  This is all possible, but none of it easy.